Fixed Assets and Intangible Assets Chapter 10

Learning Objective 1 Define, classify, and account for the cost of fixed assets

Nature of Fixed Assets Fixed assets are long-term or relatively permanent assets, such as equipment, machinery, buildings, and land. Other descriptive titles for fixed assets are plant assets or property, plant, and equipment.

Nature of Fixed Assets Fixed assets have the following characteristics: They exist physically and, thus, are tangible assets. They are owned and used by the company in its normal operations. They are not offered for sale as part of normal operations.

CLASSIFYING COSTS

Costs of Acquiring Fixed Assets Only costs necessary for preparing the fixed asset for use are included as a cost of the asset. Unnecessary costs that do not increase the asset’s usefulness are recorded as an expense. Vandalism Mistakes in installation Uninsured theft Damage during unpacking and installing Fines for not obtaining proper permits from government agencies

Capital and Revenue Expenditures Expenditures that benefit only the current period are called revenue expenditures. Normal and ordinary repairs and maintenance Expenditures that improve the asset or extend its useful life are capital expenditures. Additions, improvements, and extraordinary repairs

Ordinary Maintenance and Repairs On April 9, the firm paid $300 for a tune-up of a delivery truck. Costs related to the ordinary maintenance and repairs of fixed assets are recorded as an expense of the current period. revenue expenditure

Asset Improvements On May 4, a $5,500 hydraulic lift was installed on the delivery truck to allow for easier and quicker loading of heavy cargo. After a fixed asset has been placed in service, cost may be incurred to improve the asset. capital expenditure

Extraordinary Repairs The engine of a forklift that is near the end of its useful life is overhauled at a cost of $4,500, which extends its useful life by eight years. Work on the forklift was completed on October 14. After a fixed asset has been placed in service, cost may be incurred to improve the asset. capital expenditure

CAPITAL AND REVENUE EXPENDITURES

Leasing Fixed Assets A Lease is a contract for the use of an asset for a period of time e.g. automobiles, computers, buildings and airplanes are often leased. The two parties to a lease contract are as follows: The lessor is the party who owns the asset. The lessee is the party to whom the rights to use the asset are granted by the lessor.

Leasing Fixed Assets A capital lease is accounted for as if the lessee has, in fact, purchased the asset. The asset is then amortized (written off as an expense) over the life of the capital lease. A lease that is not classified as a capital lease for accounting purposes is classified as an operating lease. An operating lease is treated as an expense, because the lessee is renting the asset for the lease term.

Learning Objective 2 Compute depreciation, using the following methods: straight-line method, units-of-production method, and double-declining-balance method

Depreciation Over time, most fixed assets (equipment, buildings, and land improvements) lose their ability to provide services. The periodic recording of the cost of fixed assets as an expense is called depreciation.

Accounting for Depreciation Depreciation can be caused by physical or functional factors. Physical depreciation factors include wear and tear during use or from exposure to the weather. Functional depreciation factors include obsolescence and changes in customer needs that cause the asset to no longer provide services for which it was intended.

Accounting for Depreciation Two common misunderstandings that exist about depreciation as used in accounting include: Depreciation does not measure a decline in the market value of a fixed asset. Depreciation does not provide cash to replace fixed assets as they wear out.

Factors in Computing Depreciation Three factors determine the depreciation expense for a fixed asset. These three factors are: The asset’s initial cost The asset’s expected useful life The asset’s estimated residual value

Factors in Computing Depreciation The expected useful life of a fixed asset is estimated at the time the asset is placed into service. The residual value of a fixed asset at the end of its useful life is also estimated at the time the asset is placed into service.

INITIAL COST – ACCUMULATED DEPRECIATION = BOOK VALUE

The three Depreciation methods: (used more often) Straight line method Units-of-production deprecation Double declining balance method

Straight-Line Method The straight-line method provides for the same amount of depreciation expense for each year of the asset’s useful life. Annual Depreciation Cost – Residual Value Useful Life =

Straight-Line Method Initial cost: $24,000 Expected useful life 5 years Estimated residual value: $2,000 The annual straight-line depreciation of $4,400 is computed below: Annual Depreciation = Cost – Residual Value Useful Life $24,000 - $2,000 5 years = $22,000 5 years = = $4,400

Accumulated Depreciation Straight-Line Method Initial Cost – Accumulated depreciation $22,000 5 years = = $4,400 Annual Depreciation Year cost Depreciation exp Accumulated Depreciation Book value 1 24,000 4,400 19,600 2 8,800 15,200 3 13200 10,800 4 17600 6,400 5 22,000 2,000 Last book value Equals residual value Last Accumulated Depreciation Equals depreciable value

Straight-Line Method If the preceding equipment was purchased and placed into service on October 1, the depreciation for the first year of use would be $1,100, computed as follows: $4,400 x 3/12 = $1,100

Straight-Line Method The straight-line percentage can be determined by dividing 100% by the number of years of expected useful life, as shown below.

Units-of-Production Method The units-of-production method provides the same amount of depreciation expense for each unit produced or each unit of capacity used by the asset. Step 1. Determine the depreciation per unit as: Step 2. Compute the depreciation expense as: Depreciation per Unit = Cost – Residual Value Total Units of Production Depreciation Expense = Depreciation per Unit x Total Units of Output Used

Units-of-Production Method A depreciable asset costs $24,000. Its estimated residual value is $2,000, and it is expected to have a useful life of 10,000 operating hours. During the year, the asset was operated 2,100 hours. Depreciation per hour= (24,000- 2,000)/10,000 hours = 2.20 per hour 2. Depreciation expense= 2.20 x 2100 = $ 4,620

Units-of-Production Method Initial Cost – Accumulated depreciation Depreciation per hour= (24,000- 2,000)/10,000 hours = 2.20 per hour operating hours Year cost Depreciation exp Accumulated Depreciation Book value 2,100 1 24,000 4,620 19,380 2 3 4 5 Total operating hours Equal useful life Last Accumulated Depreciation Equals depreciable value Last book value Equals residual value

Double-Declining-Balance Method The double-declining-balance method provides for a declining periodic expense over the expected useful life of the asset.

Double-Declining-Balance Method The double-declining-balance method is applied in three steps: Step 1. Determine the straight-line percentage using the expected useful life. Step 2. Determine the double-declining-balance rate by multiplying the straight-line rate from Step 1 by 2. Step 3. Compute the depreciation expense by multiplying the double-declining-balance rate from Step 2 times the book value of the asset. (continued)

Double-Declining-Balance Method The double-declining-balance rate is determined by doubling the straight-line rate. A shortcut to determining the straight-line rate is to divide one by the number of years (for example, 1 ÷ 5 = 0.20). Using the double-declining-balance method, a five-year life results in a 40 percent rate (0.20 × 2).

Double-Declining-Balance Method For the first year, the book value of the equipment is its initial cost of $24,000. After the first year, the book value (cost - accumulated depreciation) declines and, thus, the depreciation also declines.

Double-Declining-Balance Method Initial Cost – Accumulated depreciation   Year cost Book value at the Beginning of the year Depreciation exp = 0.40 X Book value at the Beginning of the year Accumulated Depreciation Book value at the End of the year 1 24,000 9,600 14,400 2 5,760 15,360 8,640 3 3,456 18,816 5,184 4 2,073.6 20,889.6 3,110.4 5 3110.40 - 2000 OR 22000 – 20889.6 1,110.4 22,000 2,000 Last Accumulated Depreciation Equals depreciable value Last book value Equals residual value

Double-Declining-Balance Method The double-declining-balance depreciation for the full five-year life of the equipment is shown below. 3110.40-2000 DEPRECIATION STOPS WHEN BOOK VALUE EQUALS RESIDUAL VALUE! STOP

Double-Declining-Balance Method “Forced” depreciation for 5th year Desired ending book value

Double-Declining-Balance Method If the preceding equipment was purchased and placed into service on October 1, depreciation for the year ending December 31 would be $2,400, computed as follows: = $9,600 x 3/12 = $2,400 First year partial depreciation The depreciation for the second year would then be $8,640, computed as follows: = [40% x ($24,000 – $2,400)] Second year depreciation = $8,640

Double-Declining-Balance Method The double-declining-balance method provides a higher depreciation in the first year of the asset’s use, followed by declining depreciation amounts. Thus, it is called an accelerated depreciation method.

Comparing Depreciation Methods

Comparing Depreciation Methods

Depreciation for Federal Income Tax

Learning Objective 3 Journalize entries for the disposal of fixed assets

Disposal of Fixed Assets Fixed assets that are no longer useful may be discarded or sold. In such cases, the fixed asset is removed from the accounts. Just because a fixed asset is fully depreciated, however, doesn’t mean that it should be removed from the accounts (as long as asset is being used)

Discarding Fixed Assets If a fixed asset is no longer used and has no residual value, it’s discarded. Equipment acquired at a cost of $25,000 is fully depreciation at December 31, 2013. On February 14, 2014, the equipment is discarded.

Discarding Fixed Assets Equipment costing $6,000, with no residual value, is depreciated at an annual straight-line rate of 10%. After the December 31, 2013, adjusting entry, Accumulated Depreciation— Equipment has a $4,650 balance. On March 24, 2014, the asset is removed from service and discarded.

Discarding Fixed Assets

Discarding Fixed Assets The discarding of the equipment is then recorded as shown below. (Note that this is the second of two entries on March 24.) 4650 + 150 = 4800 6000 – 4800 = 1200

Selling Fixed Assets The entry to records the sale of the fixed assets is similar to the entries for discarding an asset. The only difference is recording the receipt of cash. If selling price > book value  Gain If selling price < book value  Loss Equipment was purchased at a cost of $10,000. It had no estimated residual value and was depreciated at a straight-line rate of 10%. The equipment is sold for cash on October 12 of the eighth year of its use. The balance of the accumulated depreciation account as of the preceding December 31 is $7,000. (continued)

Selling Fixed Assets The entry to update the depreciation for the nine months of the current year is as follows: 10000 X 10% = 1000 1000 X 9/12 = 750 (continued) 7000 + 750 = 7750

Selling Fixed Assets After the current depreciation is recorded, the book value of the asset is $2,250 ($10,000 – $7,750).

Selling Fixed Assets After the current depreciation is recorded, the book value of the asset is $2,250 ($10,000 – $7,750).

Selling Fixed Assets After the current depreciation is recorded, the book value of the asset is $2,250 ($10,000 – $7,750).

Learning Objective 4 Compute depletion and journalize the entry for depletion

Learning Objective 5 Describe the accounting for intangible assets, such as patents, copyrights, and goodwill

Intangible Assets Patents, copyrights, trademarks, and goodwill are long-lived assets that are used in the operations of a business and not held for sale. These assets are called intangible assets because they do not exist physically.

Intangible Assets The accounting for intangible assets is similar to that for fixed assets. The major issues are: Determining the initial cost. Determining the amortization, which is the amount of cost to transfer to expense.

COMPARISON OF INTANGIBLE ASSETS

Learning Objective 6 Describe how depreciation expense is reported in an income statement and prepare a balance sheet that includes fixed assets and intangible assets

Fixed and Intangible Assets

Fixed and Intangible Assets In the Income Statement, depreciation expense should be reported separately. A description of the methods used in computing depreciation should also be reported In the Balance sheet, each class of fixed assets should be disclosed on the face of the statement or in the notes. The related accumulated deprecation should be disclosed, either by class or total Intangible assets are usually reported in the balance sheet in a separate section following fixed asset

Fixed and Intangible Assets Intangible assets are usually reported in the balance sheet in a separate section following fixed assets. The balance of each class of intangible assets should be disclosed net of any amortization. The cost and related accumulated depletion of mineral rights are normally shown as part of the Fixed Assets section of the balance sheet.

Learning Objective 7 Describe and illustrate the fixed asset turnover ratio to assess the efficiency of a company’s use of its fixed assets

H.W: PE 10-1A PE 10-2A , PE 10-2B PE 10-3A , PE10-3B PE10-4A , PE10-4B PE10-6A EX10-9 EX10-10 EX10-12 EX10-13 EX10-14

Fixed Assets and Intangible Assets The End